In a combination that has become common despite economic logic, equities and bonds both rose today as better than expected sales and jobless claims data supported stocks, and news reports stated that the Fed is no hurry to raise short term rates even with an improving economy.
The Dow gained 180.85 points 1.21% to 15.176.10 as retails sales in May came in at 0.6% against the 0.4% forecast and initial jobless claims were 334,000 on expectations for 346,000.
The yield on the 10-year US Treasury fell 8 basis points to 2.15% as traders pared back speculation that the Federal Reserve will begin tapering or ending its quantitative easing program.
Historically equity prices gain as economic performance improves and bonds prices fall and yields rise as credit markets presage an eventual credit tightening cycle from the central bank to head off an overheated economy and inflation.
Since the Fed began its extraordinary effort to drive down market rates with quantitative easing rates had remained low, with the 10-year under 2.0% for most of the past year, because the Fed was absorbing any selling pressure in the Treasury market that might have forced rates higher.
Bond prices and yields move in opposite directions because changes in the bond price must adjust for the difference between the fixed coupon rate and the market rate.
The central bank had been at pains to convince the credit markets that it will not withdraw its $85 billion a month securities purchases until economic growth is self-sustaining and will not raise the Fed Funds rate from 0.25% until unemployment reaches 6.5%.
But comments from Chairman Bernanke and other board members over the past several weeks had convinced many in the credit markets that the beginning of the end of quantitative easing was closer than previously thought. The 10-year Treasury yield rose from 1.63% on May 2nd to 2.23% before heading down today.
The credit markets may have gotten a bit ahead of themselves in anticipating the end of quantitative easing. Chairman Bernanke will not doubt have more to say on the matter next week at the FOMC pass conference on the 19th.
If the economy continues to get better, no amount of Fed talk will dissuade the markets that the next move in rates is not higher, no matter what the central bank does with the Fed Funds rates.
Credit markets have every reason to get ahead of the curve of Fed policy. As long as the economy doesn’t reverse, it is probably a good bet.
Chief Market Strategist